Midterm Exam in Introduction to Economics: Questions and Answers, Exams of Economics

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Name: Key

Economics 151, Introduction to Economics

Midterm 2

March 13, 2008

100 Points Possible

Score: 100

Multiple Choice. Select one “BEST” answer for each question. (3 points each)

(^1) I recently loaned $25 to a person through Kiva. My opportunity cost is: a) (^) There is no opportunity cost. b) (^) $ c) (^) $25 plus foregone interest that I could have earned by putting $25 in the bank. d) Foregone interest that I could have earned by putting $25 in the bank. (Since this is a LOAN, you have a reasonable expectation that your $25 will be returned. The only cost is the interest you could have earned from a traditional loan. This question is a preview of a macroeconomic topic we will cover.) 2 Bob and Joe are neighbors who shared a dirt driveway. Joe had saved money to create a new paved driveway to his own house. Not realizing this, Bob put gravel on the old driveway. Which of the following is inconsistent with good economic decision making? a) (^) Joe still wants to pave a new driveway, because he believes MB > MC. b) (^) Joe no longer wants to pave a new driveway, because the MB has decreased. c) Joe no longer wants to pave a new driveway, because the MC has increased. (The marginal cost of paving a new driveway has not changed. The marginal benefits may have.) d) (^) None of the above is inconsistent with good decision making. 3 Which of the following is true about the short-run profits of perfectly competitive increasing-cost industry and constant-cost industry firms? a) (^) They earn equal profit. b) (^) Firms in increasing cost industries earn more profit. c) (^) Firms in increasing cost industries earn less profit. d) (^) Any of the above could be true. We need more information. (^4) Supply curves represent the marginal cost of production for: a) (^) Perfectly competitive firms. b) (^) Monopolistically competitive firms. c) (^) Monopolies. d) (^) All of the above. (^5) In the long run, perfectly competitive firms generally earn a) (^) Zero accounting profit b) (^) Zero economic profit c) (^) Zero accounting and economic profit d) (^) Positive accounting and economic profit (^6) Incentives for innovation are greatest if the innovation will be part of a: a) (^) Perfectly competitive market. b) (^) Monopolistically competitive market. c) (^) Monopoly market. d) (^) Both b and c are acceptable.

Short Answer.

1) Price Discrimination (6 points)

Sony has a monopoly on the Playstation video game system. Suppose Sony faces a constant

marginal cost of $200 for each Playstation that it manufactures. Let’s also assume that Sony

knows each customer’s marginal willingness to pay, and that it uses this information to

perfectly price discriminate.

Jaime has a marginal willingness to pay of $400. Anthony has a marginal willingness to pay

equal to $250. Sarah’s MWTP is $50.

What are the values of the consumer surplus, producer surplus, and deadweight loss

associated with the total transactions that we know will occur in this market?

There is no CS because individuals pay their MWTP.

PS = 250 (400-200 from Jaime, 250-200 from Anthony, 0 from Sarah who does not buy the

product).

DWL = 0. All people who value the product more than its marginal cost will receive it. Also,

there are no externalities. The allocation is efficient.

2) Negative Externalities (3 points)

The government has decided to regulate a polluting firm by taxing it for every pound of CO 2

it emits. Pollution abatement machines are available for purchase. How will the firm choose

the number of pollution abatement machines it will buy?

The firm buys abatement machines as long as the marginal benefit of doing so (reducing

their tax burden) is greater than or equal to the marginal cost (the price of a new machine).

3) Monopolistic Competition

A monopolistically competitive firm faces the following demand, marginal cost, and average

cost curves in the long run:

Demand: P = 50 – Q

Marginal Cost: MC = 10 + 3*Q

Average Cost: AC = 10 + 1.5*Q + F/Q

Where “F” is some unknown dollar value.

A) How much profit is the firm earning in the long run? (3 points)

Monopolistically competitive firms earn zero profit in the long run.

B) What is the key assumption that allows you to find your value in Part A? (3 points)

We know that monopolistically competitive firms earn zero profit in the long run because

there are NO BARRIERS TO ENTRY. (Firms earning positive profit would attract

competition until everyone earns zero economic profit).

4) Monopoly Suppose the National Football League has a monopoly on luxury box tickets for a particular game. Assume that men and women have different demand schedules for these tickets, but the NFL chooses not to price discriminate. The demand schedules and marginal cost of providing the tickets are: Men: P = 1500 – Q Women: P = 1000 – Q Marginal Cost: MC = 100 + (1/2)*Q

A) Use the space below to draw a demand curve for tickets. Make sure to label the intercepts at the value of

the kink in your demand curve. (Also, make sure to give yourself enough space, because you will be adding elements to your diagram in Parts…) (5 points) The demand curve after the kink (500, 1000) is P = 1250 – (1/2)*Q. (From horizontal addition, or see HW 7, or simply ask how many goods would be demanded if P=0) B) Draw a marginal revenue curve. Hint: The marginal revenue equation after the kink in demand is MR = 1000 – Q. (5 points)

C) How many tickets will the NFL sell? (4 points)

MR = MC => 1000 – Q = 100 + 0.5*Q => Q = 600

D) What price will the NFL charge? (4 points)

Substitute Q=600 into the combined Demand Equation: P = 1250 – 0.5*(600) = 950

E) Indicate the consumer surplus, producer surplus, and deadweight loss on the diagram, but please do not

compute the values. (4 points) 0, 15000, 1500 2500, 0 600, 950 500, 1000 600, 400 500, 500 1000, 0 0 250 500 750 1000 1250 1500 1750 0 500 1000 1500 2000 2500 3000 Q $ MC MR D 500, PS^ DWL CS